Key Questions To Ask When Performing Due Diligence On Your Deal Sponsorship Team

Some deals aren’t worth your investment. For effective decision-making and sound investing, establish a baseline with these key questions.

In real estate, return on investment isn’t nearly as crucial as preservation of capital. It’s better to walk away from investing than to invest in a bad deal. Before you make any decisions, it's important to create guidelines for both mitigating your risks and making sound decisions. Need help? Here are eight essential questions to ask a deal sponsorship team when performing due diligence on a multifamily investment opportunity.

1. Are you investing your own money in this deal? If so, how much?

When a sponsor presents an investment opportunity, this is one of the most important questions any investor should ask. A sponsorship team with some "skin in the game" can help ensure interests are aligned among all parties. Sponsors with their own capital invested will be more driven to perform well in their job and its corresponding responsibilities since they are also financially tied to the investment.

However, it’s important to remember that just because a sponsor doesn’t have a lot of money invested doesn’t necessarily mean it’s a bad deal. A highly experienced sponsor tends to do more deals involving larger properties, and it becomes difficult for them to contribute large amounts of capital in every deal. Their investment may not be large, but it also doesn’t have to be zero.

2. How much experience does the property management company have? How do their other properties compare to this one?

One of your most critical partners in a successful investment strategy is your property manager. But not all property managers are equal. They should have experience in the same market as your investment, and their portfolio should match the asset type associated with the investment property. For example, a property manager is not likely to be successful with class "C" properties if the majority of their experience is with class "A". Make sure the property manager hired by your sponsor has or currently manages similar properties in the area.

3. What concerns you most about this property?

Each investment opportunity will have some drawbacks and risks. Your sponsorship team should be transparent about diagnosing all potential problems in an investment opportunity. Consider it a red flag if a sponsorship team cannot name at least one possible issue.

4. What fees will be charged?

An acquisition fee is typical in most real estate syndication or deal structures. This fee compensates the sponsorship team for their expertise and hard work in identifying the property, making the offering available to investors, and raising the capital to close. Acquisition fees are typically between 1-3% of the purchase price.

Additionally, the sponsorship team frequently charges an asset management fee for the ongoing management of the investment and executing the investment strategy. Typically, an asset management fee is between 1-3% of the total income collected or the total amount of equity raised.

5. Does this deal offer a preferred return?

A preferred return (pref) offered with an investment is structured so that the equity investors (or limited partners) receive profit distributions first at a certain percentage point, before the general partners are paid their asset management fee, profits, etc., on distributions. This helps to create aligned interests among all parties.

An investment offering can also allow for an equity-split-only structure on distributions where every dollar of cash flow is split with the sponsors based on the amount of equity they retain. While each structure has advantages and disadvantages, an investor needs to understand the implications of either choice and how it impacts their investment returns.

6. Have you surveyed and visited the comps? What makes you certain that this property can achieve the projected rents?

Upon performing due diligence on a multifamily investment opportunity, your sponsor should also:

  • conduct a rent survey that supports their decision-making on rent projections
  • visit comparable properties (comps) to form a detailed understanding of the local area and their competition

Taking these steps gives the sponsorship team a clear concept of what attributes their property will need to be competitive. Even more, the comps should be like-kind to the property being acquired. A Class "C" property built 50 years ago is understandably not a good comparable to a Class "A" property built 5 years ago.

7. How did you determine the property taxes in your financial projections?

The biggest expense on a multifamily investment property is often the property taxes. Having to absorb unexpected increases in real estate taxes can be detrimental to any investment and can heavily impact return projections. Your sponsorship team should consult with the local municipality and the tax assessment office on exactly how the new purchase will likely increase their property tax liability over time. If not properly factored into the projections, property taxes can be a dangerous oversight.

8. Does the insurance policy cover the loss of rental income and the full cost to rebuild?

Purchasing proper insurance coverage is essential when acquiring a large asset. Your investment needs to be protected from a financial hit resulting from weather damage, fire damage, accidents, and natural disasters.

A good multifamily sponsorship team will always have coverage for loss of rental income and cost reimbursement in case of fire at the property. A detailed understanding of these coverage options affords extra security on the investment opportunity, and provides operators added assurance over their investment if the property cannot operate.

To succeed as a passive investor, it is critical that you perform adequate due diligence on the sponsorship team that will be managing investments on your behalf. We welcome these types of questions from our investors because we are prepared for them. Before we present an investment opportunity to our Investor Group, we do very thorough due diligence of our own. If you are interested in seeing our deal presentations when opportunities arise, please get in touch. Let’s start the conversation today.

Photo by Andrea Piacquadio from Pexels

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